This method is used to calculate fixed, semi-variable and variable costs using limited data.
FIXED COST is a cost that stays the same regardless of activity levels.
Rent is an example of a fixed cost. The payments may stay consistent throughout the year regardless if 10,000 products are made or none.
SEMI VARIABLE or stepped costs change at a particular activity level.
This could be costs of storing goods for example where by each time 1000 units of stock are added to the stores additional space is required at an additional cost.
VARIABLE COST are costs that change depending on activities levels.
An example might be that 10g of material is needed to make each product. And this costs 5p for 10g. Costs would vary depending on how many products are produced. 1000 products would need 10,000g at a cost of £50
Here is how the High-Low Method might be used:
- 100 units – cost £186
- 150 units – cost £261
- 200 units – cost £336
- 350 units – cost £561
To calculate fixed and variable costs take the highest and lowest activities levels. The High- Low Method
- Highest – Lowest
- 350 units – 100 units = 250 units
- £561 – £186 = £375
£375 divided by 250 = £1.50 per unit. The variable cost.
So if 100 units cost 1.50 per unit why does it not cost £150?
Total Cost = Fixed Cost + Variable Cost
The difference between the variable cost and the actual cost is the fixed element being £36 in this example.
Why is this useful?
It might not be profitable to make 1001 products if having that extra 1 product means an additional store, staff member, or bulk buy of materials for example.
Knowing the fixed and variable costs of a business means costs and production levels can be budgeted for among other things.
If you want to know more, reach out as we specialise in helping business owners to better understand their numbers.